Inflation: The needle that pops the Debt Bubble

Happy Mothers Day to the moms!

I read an excellent commentary over the weekend from Bill Fleckenstein that I wanted to share with everyone today. He discusses the new worldwide inflation threat that isn't going anywhere anytime soon. I put this in the must read category. We have discussed many of these issues on this blog, and the economist in the article expects a blowup most likely within the next couple years.

Here are some highlights:

"One major force helped hold inflation at bay during the 1990s: globalization. As Jim Grant points out in a brilliant essay titled "The Close of the Era of Peace and Quiet" in the current Grant's Interest Rate Observer (subscription required): "Between the early 1980s and the late 1990s, an estimated 2 billion new pairs of hands had joined the global labor force. Employers never had it so good, especially so in countries like the United States, where relocation to low-cost meccas of the East was no idle threat, but an actionable business plan."

Cheap labor, when combined with the technological advances of the late 1990s -- which were powerful, though no more potent than those we'd seen in the 1920s and 1960s, for instance -- helped offset the Federal Reserve's money printing.

However, in the wake of the stock bubble, that money printing set off the U.S. housing boom and began to cause different consequences.

Exacerbating those inflation trends is the synchronized economic boom that the world has enjoyed for the past couple of decades, which is a major focus of Marc Faber, the editor of the Gloom, Boom & Doom Report (subscription required).

Combining Grant's and Faber's views, we see that the first decade of the global economic boom and the attendant expansion in the labor force held inflation in check. Now those laborers all over the world want more money, and economic expansion in countries everywhere is creating a tremendous drain on the world's resources, leading to higher commodity prices."

Quick Take:

So we have been enjoying the deflationary cheap labor from China over the past couple of decades which has helped fuel a massive global expansion. However, workers in these countries are now demanding more money, and higher food prices are fueling this demand.

Back to the commentary:

"The president of the World Bank, Robert Zoellick, speculates that inflation has pushed 33 countries to the edge of civil insurrection. If globalization has made one world economy out of a myriad of national economies, it follows that inflation is a world problem, not a localized one."

The world itself could be looked at as one economy in the late stages of a business cycle -- in which capital spending is exploding, especially in fast-growing regions such as Asia, the Middle East and parts of South America. Inflation is rising, and certain sectors are starting to have problems.

The U.S. can be considered one of those sectors, with the burst real-estate bubble already starting to impact demand in the world while inflation is eats away at the world's ability to consume.

Faber points out a major concern: The debt-burdened U.S. economy may have reached "zero hour" -- that being when a dollar of new debt has no incremental positive impact on U.S. gross domestic product.

For the past 30 or 40 years, it's taken increasingly larger amounts of debt to increase GDP. From 2000 to 2007, total credit market growth was $21 trillion, and nominal GDP growth was only $4 trillion. We have reached the stage where a dollar in debt produces only 20 cents or so in economic growth (versus about 90 cents produced in the 1960s).

That leads to one of Faber's conclusions: "It is quite likely that the current synchronized global economic boom and the universal, all-encompassing asset bubble will lead to a colossal bust."

For the past 30 or 40 years, it's taken increasingly larger amounts of debt to increase GDP. From 2000 to 2007, total credit market growth was $21 trillion, and nominal GDP growth was only $4 trillion. We have reached the stage where a dollar in debt produces only 20 cents or so in economic growth (versus about 90 cents produced in the 1960s).

An economy that reaches Faber's zero hour is one in which increasing debt creates no growth. It only increases prices.

The unanswerable question is how long the world debt markets will allow inflation to ratchet up before they start to decline, as they price in, say, a 6% inflation rate and 2% to 3% of "real" yields!

Faber offered that either the debt markets will have to crack or commodity prices will have to break."


My Take:

Well this article basically explains why we are heading for a economic disaster. The inflation described on here will be the needle that pops the debt balloon in my opinion.

We already know that deflation WILL hit the debt markets as inflation takes away discretionary spending. Remember folks, inflation and deflation can happen at the same time.

When you smack the already weakened consumer with a fat dose of inflation, you are asking for big trouble. The housing bubble has already brought the consumer to its knees. This second blow(inflation) will knock them out.

As you can see above, the GDP can only be Ponzied upward so much with debt until it stops growing because we can no longer afford to service the debt. According to the data above, the debt game has almost completely stopped working.

Consumers are overwhelmed right now between mortgage payments and rising prices. The way the Fed measures inflation is a joke(excluding food and fuel). Eventually, the bond market is going to wake up and crash as they start to realize inflation is really at 6% and the debt game no longer works.

This will force a massive blowup, and the economy will go through a massive reset where everything becomes synchronized. Affordability will then be back, but not before a ton of financial pain in the stock market.